James Sullivan

Help Debt-Stricken Vulnerable Seniors

Faced with crushing debt, many seniors will need CPA guidance as they are forced to choose between a financially bleak old age and some form of debt relief.

May 9, 2011
by James Sullivan, CPA, PFS

A lifetime of poor financial habits finally caught up to Otto and Miriam. Otto is 74 and retired. Miriam at age 65 had just lost her job paying $200,000 annually. Despite earning high incomes most of their lives, the couple has little to show for it. Otto has run up credit card debt of almost $140,000, while Miriam owes $14,000 to the credit card companies.

Otto had long ago begun draining his retirement accounts to pay his mounting credit card debt. Last year, he withdrew his last $30,000 to make the monthly payments toward the existing credit card debt. Miriam had managed to save $318,000 in her 401(k) account. Their only other asset is approximately $300,000 of equity in their home.

Miriam is not confident she can find another job paying a salary anywhere near what she had been earning. Otto has health problems that make it impossible for him to return to work. He receives a monthly pension of $850 and a Social Security benefit of $1,800. Other than her retirement savings and six months of severance payments, Miriam will have no steady source of income. She is considering filing for her Social Security benefit, which will pay $1,800 a month.

A Bleak Outlook

Should they sell their home, Otto and Miriam will have approximately $270,000 (after the costs of sale) with which to pay their $154,000 credit card debt. The remainder or $116,000 would be put toward their retirement savings. Their CPA points out that their total savings of $434,000 ($318,000 in Miriam’s retirement account plus $116,000 net proceeds from the sale of their house) will not support their current lifestyle even if Miriam begins receiving her Social Security. Even if they cut their spending drastically, their nest egg will not last the 30 nor 35 years that it may be needed should Miriam live to age 95 or 100 (Miriam’s mother is still living at age 92 in relatively good health; her dad died four years ago at age 90).

With Miriam out of work, the monthly credit card payments are unsustainable. Even if she should find a job paying the same salary she had been receiving they will be unable to save towards her retirement.

A Value Judgment

Of course, neither Otto nor Miriam ever thought they would be in this position. Without seeking some form of debt relief, the couple faces a bleak financial future. It is as much a value judgment for the couple as a financial decision. While they could sell their home and pay off the debt, they should understand the financial position that puts them in. As much as it goes against what they were raised to believe — pay off your debts — their CPA suggests that they at least consider the alternatives.

The Alternatives

The CPA lays out the following alternatives for discussion:

  • Sell their home and apply any net proceeds to the credit card debt. Any remainder will go towards their retirement savings. Should Miriam find work, their prospects would improve considerably. More of her earnings could then go towards building up their retirement savings.
  • Seek credit counseling from a nonprofit credit card counseling agency. One avenue of relief offered by such agencies is a Debt Management Plan (DMP). Once accepted into a DMP, the credit card companies will offer lower interest rates resulting in a much lower monthly payment. Unfortunately, the credit card companies may determine that the couple will not have sufficient income to support the DMP payments unless Miriam finds a job. Without a job, they may not be accepted into the program.
  • Offer to settle the debt with the credit card companies for less than the full balance owed (a debt settlement). The credit card company will require immediate payment of the agreed amount to extinguish the debt, but this may be more attractive than using the home sale proceeds to pay off the entire debt. For example, the credit card companies may agree to settle the full amount due for $60,000 (or less). The payment could be paid with the proceeds of the house sale. A catch: The amount of the debt forgiven will be treated as taxable income.
  • Declare bankruptcy. Otto and Miriam need not both declare bankruptcy. Because the bulk of the debt is in Otto’s name, he can declare bankruptcy, while Miriam does not. Miriam’s $14,000 debt can be paid with the proceeds of the house sale (which would occur after the bankruptcy judgment). In effect, Miriam’s credit score is protected. The CPA points out that the bankruptcy is a legal procedure. He recommends that they make an appointment with a bankruptcy attorney. They need to understand the bankruptcy laws as they pertain in their state. For example, is their remaining home equity protected should Otto declare bankruptcy since this is a jointly owned asset? What about Miriam’s retirement account? Is the account protected from Otto’s creditors?

The Best Choice of a Bad List of Alternatives

Otto and Miriam are faced with selecting the best of a bad list of available alternatives. All alternatives except immediate, full payment of the debt will further harm at least Otto’s credit score. The monthly payments are not sustainable should Miriam remain unemployed — to do nothing is not an alternative. If Miriam is unable to find work quickly, they will have to dip into her retirement funds to continue making the monthly payments. They will be using money from an account that is otherwise protected in bankruptcy to pay off unsecured debt.

Even if Miriam does find a new job at the same salary, they are in a debt hole so deep they will never be able to climb out absent the sale of their home and a drastic change in their lifestyle. To pay off the debt in full, leaves them even more financially vulnerable as they grow older.

The Decision

Otto decides to seek bankruptcy on his own. He met with an experienced bankruptcy attorney to begin the process. He and Miriam also decided to proceed with the sale of their home, but would determine the timing once Otto consulted with the bankruptcy attorney. Miriam continued her job search with little success. The attorney told Otto that due to state laws, their remaining home equity was protected and that Miriam’s individual retirement account (IRA) was beyond the reach of her creditors even if she filed for bankruptcy.
The Older Adult and Debt Problems

A 2010 University of Michigan Law School study revealed that people aged 65 and older are the fastest growing segment of the U.S. population filing for bankruptcy. Debt problems can impose hardships on the elderly well before they are forced to seek bankruptcy protection. Otto and Miriam may be an extreme case, but many retirees face the same issues.

While most financial planning for those in or near retirement focuses on investing in retirement and determining the best annual withdrawal rate from a nest egg, the growing debt problems of older adults have not been adequately addressed by the planning community. Unfortunately, this growing problem will have to be addressed more in the very near future. CPAs have a role to play.

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James Sullivan, CPA, PFS, works with his wife, Janet, who is an elder law attorney in Naperville, Illinois.

* PFP Section members, including PFS credential holders will benefit from additional Eldercare resources in Forefield Advisor on the AICPA’s PFP website at aicpa.org/pfp. Non-members can click here to join the section.